Is automated financial advice what you need? Explore the benefits and drawbacks of using a robo-advisor.

Once upon a time, individuals largely relied on traditional financial advisors for investment guidance, who specialized in recommending the ideal mix of stocks and bonds for portfolios.

While numerous qualified brokers are still available today, many people have started to take charge of their own investments. With technology evolving, robo-advisors have emerged as a new alternative in financial advising.

Robo-advisors provide various benefits, but they also come with certain limitations. If you're thinking about using one, here’s a comprehensive overview to help you make an informed choice.

Understanding How Robo-Advisors Operate

A robo-advisor is a digital platform that delivers automated financial planning advice with minimal human input. Here’s how it functions:

  • Step One: Create an investment account with a robo-advisor.
  • Step Two: Complete a questionnaire regarding your financial goals, current situation, and risk tolerance.
  • Step Three: The robo-advisor will manage your portfolio by buying and selling assets based on your responses, following the strategies you set.
  • Step Four: In theory, your portfolio will grow according to the robo-advisor’s algorithms and market performance. You can also automate contributions from your bank account.

Benefits and Drawbacks of Robo-Advisors

ADVANTAGE: Cost-Effective

Robo-advisors operate with minimal human interaction, resulting in no broker fees. Hence, their services are generally cheaper compared to traditional financial advisors.

Fees typically range from 0.25% to 0.35%, whereas human advisors charge about 1%. Currently, robo-advisors tend to favor low-cost index funds, which are recognized as some of the most cost-effective and reliable investment options.

DISADVANTAGE: Limited Depth

Despite their affordability, robo-advisors lack comprehensive advice. They may not assist with estate planning or address broader asset allocation questions specific to your needs. If you require personalized guidance, a human advisor might be a better choice.

ADVANTAGE: Strong Performance

As of January 2020, most robo-advisors utilize low-cost index funds that tend to outperform other investment options by significant margins. However, they may not capture the high returns associated with riskier investments.

DISADVANTAGE: Absence of Personal Touch

Robo-advisors don’t provide personal consultations. Decisions about your finances are made based on a brief survey, which might not capture the nuances of your situation. Consequently, there's no one available to reassure you during market fluctuations.

ADVANTAGE: User-Friendly

Robo-advisors are designed for simplicity. If you prefer to save without much involvement, they can be ideal. Once you complete the initial setup, you can monitor your performance at your convenience without the need for meetings—these accounts represent a true “set it and forget it” approach.

That said, if you wish to be more engaged, most platforms offer intuitive interfaces that make it easy to adjust your investment priorities.

DISADVANTAGE: Potential Vulnerability During Crises

Having a traditional advisor can provide guidance during economic downturns. They can help you navigate challenging times and possibly warn you of impending issues. While robo-advisors are designed to withstand tough financial conditions, their performance in a recession remains uncertain, as they have only experienced a growing economy since their inception in 2009.

So, Are Robo-Advisors Suitable for You?

If you're contemplating a robo-advisor, the next step is to research available options and providers. Here are five popular robo-advisors to get you started:

These platforms are among the leading choices, making them a great starting point for your research.